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A Reviewer's Handbook to Business Valuation: Practical Guidance to the Use and Abuse of a Business Appraisal by Timothy R. Lee, L. Paul Hood Jr.

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Chapter 5

Valuation Approaches: The Cost Approach

In this chapter, we discuss the cost approach and its primary underlying methods. As a predicate to using methods under the cost approach, we provide an overview of common financial statement considerations and adjustments.

The Cost Approach

The goal of the cost approach is to develop an indication of value by restating the reported carrying value of the entity's assets and liabilities to the defined value called for in the valuation engagement. This approach is grounded in the concept that one element, if not the primary feature, of the value of an entity is stored on the balance sheet. There are numerous valuation methods an appraiser can employ under the cost approach. For purposes of the discussion here, we assume that the ultimate goal of the methods employed under the cost approach is to express the value of the entity's total equity. We also stipulate that the methods employed will directly develop the value of the entity's combined equity value on one of two levels of value, the controlling interest level of value or the marketable minority interest level of value. In some cases, valuation premiums or discounts may be applied to the cost approach value indication to develop an alternative level of value (such as the nonmarketable minority interest level of value).

Additionally, we will focus our discussion and framework on the context of the standard of fair market value, as is called for in the majority of appraisal assignments ...

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